By unintentionally overlooking little-known pitfalls, employers can inadvertently create a failure in their automatic enrollment programs.
The most common errors related to elective deferrals that occur in 401(k) and 403(b) plans are:
- an eligible employee is not given the opportunity to defer under the plan (missed opportunity);
- a deferral election submitted by an employee is not properly executed; and
- an eligible employee fails to be enrolled under an employer’s automatic enrollment arrangement.
For the most part, these mistakes are able to be corrected under the Employee Plans Compliance Resolution System (EPCRS). In fact, in Revenue Procedure 2015-28 the IRS responded to industry feedback that existing corrective mechanisms were too costly and too stringent by relaxing some of the rules. For example, certain penalties were decreased, and a moratorium was given for certain short-term discrepancies.
This has provided employers some relief and possibly even diminished apprehension in sponsoring automatic enrollment programs, but there are still snags that many employers may not even know exist.
While the final regulations repealed the nondiscrimination safe harbors under IRS Notice 89-23, one of the exceptions that survived is related to what is referred to as the maximum elective deferral:
“If contributions to a 403(b) annuity plan may be made pursuant to a salary reduction agreement within the meaning of section 3121(a)(5)(D), the plan meets the nondiscrimination requirements applicable to such contributions only if each participant who elects to make salary reduction contributions may elect to reduce annually his or her salary by more than $200 and the opportunity to make such contribution is available to all employees on a basis that does not discriminate in favor of highly compensated employees.”
The Notice goes on to list among the excludable employees, “each employee whose contribution to the plan under its maximum deferral percentage would be $200 or less”.
This rule is potentially problematic in an automatic enrollment program. If lower earning employees are enrolled and, based on their compensation and the default percentage that is set, their elective deferral amount for the year does not meet the $200 minimum annual amount, the plan does not satisfy universal availability.
For example, the ABC School District amends their 403(b) plan to include an Automatic Enrollment provision effective for the 2017 plan year. The auto enrollment feature states that if the employee does not make an election the school will automatically deduct 3% of their salary into the plan. Their plan does not exclude any employees from making a voluntary 403(b) deferral, and therefore would automatically include all employees. Dale is a part-time employee for the school and earns $5,000 for the year. Dale does not make an election to defer and he also does not make an affirmative election to waive participation. At the end of 2017, the payroll clerk realizes that Dale’s deferrals will only be $150. Dale cannot have deferrals that are less than $200 for the year.
According to the Examining Process, Employee Plans Technical Guidance section of the IRS Manual, “Excludable employees may be disregarded in applying the universal availability test for salary reduction contributions…These include:…Employees whose maximum elective deferrals under the plan would be no greater than $200”. Therefore, the automatic enrollment program should preclude that sector of employees to avoid a violation of the nondiscrimination rule. The ABC School District should have excluded the employees who would defer less than $200 in the eligibility section of the Adoption Agreement when the amendment was made to add the Automatic Enrollment provision.Barbara Webb, TGPC, of PenServ Plan Services, Inc., is a member of the NTSA Communications Committee.
Opinions expressed are those of the author, and do not necessarily reflect the views of NTSA or its members.